ABSTRACT
Factors such as inflation, technological change and growth often have been discussed in connection with the adequacy of provisions for depreciation under a historical cost model, there is another dimension to the capital maintenance problem and it concerns the multiplier effect of depreciation. When an amount equal to depreciation is reinvested, a firm's productive capacity tends to increase. Reinvestment of depreciation also increases a firm's financial capital if book depreciation is more accelerated than economic depreciation. During the 1930s some economists argued that because of falling prices and technological improvement, re-investment of part of the present depreciation allowances will maintain productive capacity. In contrast to the research on the bias in accounting rates of return, the emphasis in this study is on the effect of depreciation policy on financial capital. Then an index of the growth in financial capital due to depreciation is derived analytically. The index shows the bias in using book value as an estimate of financial capital.
